Monday, 31 July 2017

A constant refrain
from politicians and others is that we have to leave the EU because
we have to respect democracy, where by democracy they mean that 52%
voted to do so. Arguments that the vote was based on lies by the
Leave side are met with dismissive remarks like both sides were the
same, or what do you expect from politicians and so forth. The
important thing, we are told, is to ‘respect democracy’.

In Poland the
government recently passed a law which will dismiss all existing
judges and allow the state to directly appoint their successors. This
government was democratically elected, and the plan was in their
manifesto. So why did the Polish President veto
the plan, and why was the EU deeply concerned
about it? Surely there was a clear mandate for this policy? Shouldn’t
the President and the EU respect democracy?

The reason why the
President and the EU were right is that democracy is much more than
having elections or referendums every so often. Checks and balances,
and the rule of law, are crucial ingredients of a well functioning
democracy. But having an independent judiciary is not the only
essential characteristic of democracy besides voting.

I personally think
an important part of democracy is that politicians do not base
campaigns on complete lies, and that knowledge, evidence, facts and
expertise are respected and are easily accessible to all voters.
Otherwise elections can be won by those who tell the biggest lies. If
this happens and is not remedied democracy is a sham. As I noted
here, lies were central to the Leave campaign (more money for the
NHS, Turkey about to join the EU) and have already been shown to be
untrue, while the central plank of the Remain campaign (dubbed
Project Fear by Leave) has already come to pass. Polls suggest the
Leave lies gained
them votes. Only one side in the campaign spent a large amount of
time dismissing or denigrating academic expertise (be it economists
or lawyers).

In the US the
Republicans control Congress and the White House, all won by
democratic elections where a key part of the Republican platform was
repealing Obamacare. The Republicans therefore appear to have an
overwhelming democratic mandate for this repeal. So why are so many
people protesting against this repeal? Isn’t it important for
democracy that repeal goes ahead?

You may say that the
Republicans did not say how they would repeal Obamacare, but
neither did the Leave campaign say how they were going to leave the
EU (or rather they said whatever people wanted to hear). You may say
that Leave voters will lose their faith in the democratic system if
Brexit doesn’t happen, but the same is surely true for Republican
voters if Obamacare is not repealed. That is hardly a reason to do
it.

But referendums are
not like elections, we are told. Mandates from elections can be
challenged but referendum results must be respected. But where is it
written that referendum results (particularly those that are so
close) can never be challenged? Where is it written that we must be
bound
by the words of politicians during the referendum.[1] If it turns out
that the claims of one side in the referendum have been shown to be
false, where is it written that the referendum result should
nevertheless be cast in stone for a generation. The answer is
nowhere, and for the good reasons that David Allen Green explains.
All that is written is that parliament is sovereign.

People overseas, in
the EU or outside, are mystified at what the UK is currently doing.
The main supporter of Brexit overseas is an authoritarian regime,
which should give you a clue about what is going on. There are two
overwhelming reasons for challenging the referendum result: it was
arrived at after a deeply flawed campaign, and we now have
information that clearly shows the extent of the Leave campaign's
lies. The Leave campaign abused democracy before the vote with lies,
and then abused the word subsequently
to stifle any dissent. When a vote is won narrowly in an election
based on lies that have now been exposed, it seems to me a hallmark
of a functioning democracy is that the original vote is challenged
and voters have a chance to vote again.

[1] We could add
whether we should be bound by an electorate chosen
to keep Brexiteers happy.

Friday, 28 July 2017

In the contest
between economists and Brexiteers, which I last visited here,
the score was 5:0 and Brexit supporters were already leaving
the ground. But in that total I had not counted the 2017 Q1 GDP
figure, because it could have been a statistical blip. We now have
the first estimate of Q2 growth. I’m afraid the economists have
scored again.

You may remember
that Brexiteers made an awful lot of fuss when growth in the second
half of 2016 was mediocre [1] rather than plain bad. We now know why
that was: consumers were borrowing and running down savings. That is
not a source of sustainable growth. Growth in the first half of 2017 (2017 H1) has been virtually non-existent. As this chart shows, we have not
seen such slow growth since before the 2013 ‘recovery’ period.

What is more, what
little growth there was in 2017 H1 seems to be coming from consumption due to
more borrowing, which is worrying for the future. (We will know more
when the expenditure breakdown is released with the second estimate.)
Those who argued that Brexit would bring a short term slowdown have
been proved right: they just got their timing slightly wrong. Have
all those who earlier lambasted forecasts of a short term Brexit
slowdown offered their apologies? Pigs will fly.

Yet in his press
release when the figures were announced, Labour’s Chancellor in
waiting John McDonnell mentioned
the government’s austerity policy but not Brexit. This is
surprising, but how do we know whether austerity is to blame for this
slowdown or Brexit?

The answer is both are to blame.
After a pause, fiscal policy (to judge from the OECD’s estimate of
the underlying primary balance) started taking demand out of the
economy in 2015 and particularly 2016. That will have been an
important factor behind the slow growth in both years. However the
additional slowdown in the first half of 2017 is likely to be a
Brexit phenomenon.

For those who say
Brexit has not happened yet, the mechanism is clear. The Brexit
depreciation immediately after the vote has led to a fall in real incomes, meaning less
consumption. It has not led to any compensating increase in exports
because firms are not going to expand markets that might soon
disappear because of leaving the Single Market or customs union. The
Brexit depreciation has brought forward some of the negative impacts
of Brexit on living standards.

Yet austerity is
still to blame in the following respect. The Brexit slowdown in 2017
H1 is a slowdown in demand, not supply. Monetary policy did what it
could after the Brexit vote, but with interest rates at their lower
bound it can do no more. (I trust
there are some very embarrassed faces on the MPC right now among
those suggesting a rate rise.) Fiscal policy should have helped
monetary policy out by filling the demand gap, but those running the
Treasury refuse to acknowledge this role for fiscal policy.

So McDonnell is
correct to blame austerity, but his failure to also blame Brexit I’m
afraid reflects darker political motives. The silence on Brexit as a
cause of the current stagnation is because Labour, like the
government, supports Brexit. No one wants to say that the Brexit vote is already causing considerable damage.
Just like courtiers to a monarch, no one dares tell the king (the 52%) the bad news that their decision have brought harm in case the king takes his anger out on the messenger (the political parties).

[1] Growth in Q4 was
just below historic trends, but growth in Q3 was way below. Hence
mediocre.

Wednesday, 26 July 2017

Owen has written a
very clear account
of why he supports the referendum result, even though he campaigned
against it. He is, to use one terminology, a ‘re-leaver’, and as
he points out there are many like him. He is quite right that those
advocating overturning the referendum result have devoted
insufficient attention to this group. However I think in key respects
his argument is wrong.

I think it is
helpful, as I have done before, to set this debate in the context of
future decisions that may realistically face MPs. I can see four:

Having left
in 2019, we are likely to remain in the Single Market and customs
union while we negotiate some kind of trade agreement to allow us to
leave one or both. The first decision, which could face an incoming
Labour government, is should those negotiations continue or be
abandoned.

Owen does not
explicitly address the Single Market, which is surprising. In my
view leaving the EU but staying in the Single Market (the ‘Norway
option’) is what Labour should choose to do if it gains power. That
is fully consistent with respecting the referendum result. Those who
say that the referendum was about immigration and therefore we have
to end freedom of movement commit a simple logical error. A majority
(those who voted Leave because of immigration) of a majority (52%) is
not necessarily a majority. There is no mandate of any kind for
leaving the Single Market.

During the
vote on whether to leave in 2019, there is a vote to hold a second
referendum where the choice is to accept the deal or remain in the
EU.

Again he does not
directly address a second referendum, but some of his arguments are
relevant to it. You could argue that holding a second referendum
would disrespect the first. If the Brexit decision was changed as a
result, then Owen’s arguments about a large section of the
population losing faith in democracy would perhaps still apply.
However it seems to me the rationale for holding a second referendum
is overwhelming. In the first referendum, what leaving would entail
was very unclear. In particular, we did not know what the divorce
bill would be, and what the economic implications would be.
Information is crucial
in voting decisions. We now know much more, and therefore it seems
only right that people should be allowed to change their minds. We
are familiar with the idea of requiring new information to reopen
issues in other contexts, so why not for a referendum.

To argue that the
1975 referendum over joining was a once in a generation event is
irrelevant, because by then the nature of the deal was clear. Why
should the fact that Cameron or anyone else said this would be a once
in a generation vote bind parliament? The bottom line has to be that
if Leave cannot win two votes just a few years apart then we should
not be leaving. Remember the first referendum had an electorate
chosen to keep the Brexiteers happy, and likewise it had no super
majority. To argue that we have to respect the first referendum to
uphold faith in democracy and at the same time argue that to hold a
second referendum would be undemocratic seems a bizarre, and very
worrying, notion of democracy.

During the
vote on whether to leave in 2019, there is a vote to remain in the
EU without a second referendum

Here the referendum
would have been overruled by parliament. Owen has two, related
arguments why this would be wrong. First, both government and
opposition said that they would be bound by the referendum result.
Second, the people will have been overruled by parliament. On the
first, I agree that any MP that said their vote would be bound by the
referendum and then went against that has some explaining to do. But
an explanation along the lines of ‘I had no idea how bad Brexit was
going to be’ sounds reasonable to me. MPs, like people, are allowed
to change their minds.

I also cannot see
why pledges by the government and opposition have to bind MPs who did
not so pledge. This gets back to the nature of our representative
democracy. Although Owen does not think much of people, like me, who
keep noting that the referendum is advisory, this does express the
fact that parliament is sovereign. We live in a representative
democracy. People may be upset to learn that, but it is true. Ed
Miliband was right to rule out holding a referendum. Just because
Cameron chose to hold one to appease his right wing should not bind
the actions of MPs.

The fact that the
referendum result was achieved as the result of a completely
inadequate campaign matters. The Remain side (and the media) failed
to adequately put across their case, because the positive case for
immigration was not made. The Leave side lied their socks off. To
equate the dishonesty on the Remain side with that of the Leave
campaign, as Owen does, is quite wrong. Two central planks of the
Leave case, that the NHS would have more money and that Turkey was
about to join the EU, were complete lies. The main plank of the
Remain campaign that Brexit would reduce the real income of UK
citizens has been shown to be true. Information matters.

If such a vote was almost certain to fail because it lacked the backing of enough Conservative MPs, then there might be a tactical reason for not supporting it for reasons I outlined here. But this is not the case that Owen makes. Barry Gardiner has also departed radically from this script. As I said in that post I did not know if Labour's Brexit position was strategic or just confused and conflicted, and Owen's piece together with these recent developments reinforce such doubts.

The
government fails to negotiate a deal but wants us to leave despite
this. There is a vote in parliament to revoke Article 50 and not leave the EU.

If you remain
unconvinced by the above, consider this outcome. No deal would be a
disaster, and bring immediate chaos. But all of Owen’s arguments
for respecting the referendum would still apply! Would Owen really argue that Labour should not support such a vote for the sake of
Leave voters’ faith in democracy? If it did that it would be complicit in the chaos that followed.

Owen keeps coming
back to the impact of any decision on how those who voted Brexit
would feel. In this sense he is in the same spirit as John Harris’s
article that I discussed here.
It is an utterly defeatist argument: we must let people harm
themselves because only then might they learn that they were
mistaken in what they wanted. A much more progressive policy is to persuade people they are wrong.

If Labour
did form the next government, as I very much hope it would, the
consequences of leaving the Single Market would be on its watch.
Would those who voted Leave forgive slow growth in
their living standards as their own fault for wanting Brexit? Would
they accept the implications of low immigration for the public
finances as a price worth paying to control immigration. Of course
not. Much of the media would argue that these problems were all down
to the Labour government, not Brexit. A Labour government that
presides over leaving the Single Market could be a one term
government.

In an earlier post I
talked about the logic of a triangulation strategy for Labour, but I
said at the outset that I did not know if this what they were doing.
As a result, there is currently a serious danger that Labour would
squash any attempt from the Tory backbenches to hold a second
referendum, or if they won the next election that they would leave
the Single Market. Although everyone focuses on Corbyn, this is as
much a problem with many Labour MPs in Leave voting areas. It is an
area where we need the membership to influence Labour policy, as both
Jeremy Corbyn and Owen Jones have always suggested they should.

Monday, 24 July 2017

I often find that
arguments for Lexit have many structural similarities to right wing
arguments for Brexit. Take Larry Elliott’s latest piece
for example. This includes

Sweeping
exaggerations that seem designed to trigger nationalist sentiments.
We are told that “under Tony Blair, the feeling was that
globalisation had made the nation state redundant.”

Confusing the
EU with the Eurozone. Larry talks about the problems with the ECB,
the SGP, and mass unemployment, but these are all valid criticisms
of the Eurozone. There is no attempt to say why that has any impact
on the UK as part of the EU.

Inferring
that all the UK’s problems are somehow down to the EU, without
providing any evidence that they are.

Asserting
that the EU prevents the UK doing what it needs to do to tackle (c)
in ways that are economical with the truth (see more below).

But I also have
complaints that I think are unique to Lexit arguments. When some
people mock the use of the term neoliberalism, they should use the
Lexit debate as ammunition. When I use the term, it is to signal a
project that in various ways subordinates the state to the market.
Yet we are told that the EU had neoliberalism hardwired into it. The
EU is fundamentally about trade liberalisation, not about the role of
the state. It is trade liberalism that is hardwired into the EU, not
neoliberalism. (The Lexit advocacy here
is more honest about that.)

Is levying a huge
fine on Google because its search engine gives preference to its own
shopping comparison site an example of neoliberalism? Is a maximum
working week? Are their environmental
standards? [1] These are all examples of a collective of states
interfering with firms and the market. One of the strong and left
wing arguments for the EU is that only at this level can you avoid
large multinational corporations blackmailing states that attempted
to challenge them in similar ways. I am sure there are many examples
where the EU could do this more effectively, but at least they are
trying.

The argument for
Lexit is therefore similar to the argument against globalisation. The
problems that a combination of globalisation and technical change has
created for many communities are real enough. But Lexit arguments
typically ignore two key points. First, globalisation has brought
huge gains for many poorer countries. That applies as much to the
poorer states of the EU as it does to China and India. Of course what
is being done to Greece is appalling (and I have not hesitated to say
so on manyoccasions),
but this once again is a result of a common currency, not trade
liberalisation under the EU. Indeed, one of the reasons the
Eurozone’s blackmail of Greece worked is that a majority of Greeks
want to stay in the EU.

Second, the gains
for the UK that have followed most trade liberalisation are real
enough, which is why there are large costs to leaving the Single
Market or customs union. Larry spins this by saying the “left needs
to be very careful about running with the idea that business should
be able to veto decisions made by the electorate.” This is a line
that shows the left at its worst. The costs of Brexit do not
necessarily fall on business (which is often mobile) but on ordinary
UK citizens. What proponents of Lexit have to show is that the
benefits of the policy freedom Brexit gives you outweigh these costs.

The most promising
way to help the losers from trade liberalisation (and technical
progress) is through an active industrial and regional policy.
Proponents of Lexit argue that the EU would prevent such a strategy.
If we are talking about giving aid to declining uncompetitive sectors, then many would argue
that it is a good thing that the EU does stop that happening. But to
suggest that the EU is opposed to any kind of regional aid seems to
conflict with the existence of the EU’s Cohesion Policy, that has
benefited
many areas in the UK. For a more general discussion of the justifications the EU gives for intervening in the market, see William Davies here. The set of policies that the EU prevents but
which any reasonable trade deal with the EU would allow are prettysmall,
with the key exception of controlling immigration.

Larry says that
freedom of movement has not benefited workers. I think he would find
plenty of EU workers in the UK who would disagree (at least before
Brexit). Just as the movement of goods across borders benefits all,
so can the movement of people. Most of the analysis I have seen
has shown that recent immigration into the UK has been beneficial to
UK workers once you take everything into account. Ignoring all that
by talking about the ‘lived experience of ordinary people’ (from
here)
suggests an attitude to knowledge and evidence worthy of UKIP. Which
brings me full circle.

[1] The first of
these interventions could reflect an ordoliberal
rather than neoliberal view, but the second two not so much.

Friday, 21 July 2017

Simon Tilford has a
post
where he explores the roots of Brexit in a kind of UK exceptionalism.
He argues that “the underlying reason [for the Brexit vote] is the hubris and ignorance of much of the British elite, not just the eurosceptics among it”. I want to expand on that. I do not think this ignorance and hubris is
confined to the UK’s role in the world. It also extends to an
attitude to knowledge of all kinds, and I suspect it is possible to
date when this began to the revolutionary zeal of the right under
Thatcher.

The Thatcher
government that gained power in 1979 were going to do away with what
they saw as Keynesian nonsense, and run the economy using money supply targets. Treasury civil servants produced a forecast that said their
policy would lead to a recession, and this turned out to be what
happened. The forecast when it was made was dismissed by the
politicians in government as the product of outdated civil service
advice reflecting a failed consensus.**

It is of course the prerogative of politicians to reject a consensus, particularly if there is a reasonable minority of experts who think the consensus is wrong. It is what happened
next that was the problem. Monetarism was a monumental and predictable failure, but Conservative politicians and their supporters
spent considerable effort and resources turning this failure into a triumph of Thatcher over an
establishment civil service and academic economists. One example is
the letter from 364 economists objecting to a deflationary fiscal
policy in the 1981 budget. The right, and in particular the IEA, have successfully cultivated a belief that this letter was wrong when in fact it was
right. The recovery (using the term as it should be used) was delayed
by over a year by the 1981 budget. More generally the view was that social scientists or civil servants were probably antagonistic to
the neoliberal project and could safely be ignored. They were, in
Thatcher’s words, not one of us. [1]

The reality was that
the Thatcher and later Major governments did subsequently often take
note of what experts were saying, but the myth on the right
prevailed. Before the Conservatives regained power in 2010, they
thought very little of going against the advice of the majority of
economists over austerity, although to be fair they were later
supported in this by senior civil servants and the governor of the
Bank of England. Policy based evidence replaced evidenced based policy. But this was the relatively sane wing of the party,
as we discovered during the referendum campaign.

We know the EU
referendum campaign largely ignored experts, whether they were
economists, lawyers or experts in international relations. What I
think surprised many is that the Leavers fantasy was not just a device to
obtain votes, but actually reflected what the Brexiteers believed.
Since the referendum the government has clung to the fantasy, and
ignored or dismissed all the advice it was getting from its civil
servants. (In two cases dismissed meant
sacking or resignation.) As Steven Bullock says,
the EU side are in despair that the UK has yet to work out a
realistic position on many issues. Because large parts of
the UK public, relying on the right wing press for their news, still
believe in the fantasy, some in the main opposition party think
their best strategy is to ape their opponents.

As a result, we are
in a strange bifurcated world. One part consists of pretty well
anyone who knows anything about the economics, politics or legal
aspects of Brexit. They realise how hard Brexit will be, know how much
damage it could do, and by and large think it will be disastrous for
the UK. (Experts tend to recognise and respect knowledge in other
areas.) The other part lives in a different world, the world of the
media and politicians, where everyone still lives the fantasy.

In this respect, we
are no different from what is happening across the Atlantic. Angus
Deaton notes
the tragic irony that in the year the great nobel prize winning US
economist Ken Arrow dies, the Republican administration is ignoring
one of his great achievements, which was to show why a simple market
in healthcare will not work. The only ‘expert’ this Republican administration seems to recognise is Ayn Rand. If it is successful in
replacing or sabotaging Obamacare, millions will lose coverage and
thousands will die as a result. The experts (such as the CBO) who
predict this are accused of inaccuracy by a White House that cannot
even be bothered to check its spelling of 'inaccurately'.

May holding Trump's hand shortly after he became president was indeed symbolic. Those who justify
ignoring experts often talk
about them as ‘unaccountable elites’ who have ulterior motives in giving
the advice they do. In reality ignoring expertise means dismissing
evidence, ignoring history and experience, and eventually denying
straightforward facts. It leads to the politics of barefaced lying, such as asserting that a new trade agreement can be negotiated in little over a year. [2] This
disdain for knowledge is not a prerogative of the right: you can find
it on the left among those who say, for example,
that all social science is inherently value laden and therefore
political. (Ironically often dismissing mainstream economics as a buttress of
neoliberalism, the same economics that the right are
so keen to discredit.) The difference is that that the knowledge dismissing right have power in the UK and US, and so we are suffering
the consequences of their evidence-free politics.

[1] Sir Keith Joseph tried to abolish the Social Science Research Council.[2] It seems finally that the government has accepted a reality that was obvious months ago to those who listened to experts.

**Postscript 21/07/17 As Sasha Clarkson reminds me, one of that group now spends his time denying climate change.

Wednesday, 19 July 2017

There are two
schools of thought about why Labour is adopting a confusing and
conflicting position over Brexit which is almost the same as the
government’s line. The first is that Labour is simply confused and
conflicted. The more interesting is that this is deliberate
triangulation: sound slightly less enthusiastic about Brexit to keep
its core anti-Brexit vote, but also not to antagonise its minority
pro-Brexit vote. I do not know which view is correct, and it is
possible that both are. To the extent that it is triangulation, is
this the right thing for Labour to do? This question is related to a
recent Guardian article where John Harris argues
that although Brexit will be a disaster it has to happen.

If triangulation is
how Labour justifies its own position on Brexit, the obvious question
to ask is why they made so much fuss when their predecessors appeared
to triangulate over austerity. Brexit, like austerity, will be
extremely harmful for the economy. So what made triangulation (or
appeasement, if you want to use a more pejorative word) over
austerity a huge political mistake, but allows the same for Brexit
acceptable?

If you take the
position that political parties and politicians should always argue
for what they or their members believe in, rather than adapting their
positions to what is politically possible or smart, then there is
indeed no difference. Those who said that Labour’s failure to
campaign loudly against austerity in 2015 represented some kind of
moral betrayal should, for consistency, be arguing the same over
Brexit.

A more political
answer
would be that in the case of Brexit triangulation worked, while for
austerity it did not. In 2015 the election was all about economic
competence, and Labour triangulation on austerity had the effect of
conceding competence given the prevailing ‘clearing up the mess’
narrative. Of course Labour did not win the 2017 election, but they
achieved during the campaign a surge in popularity that is virtually
unprecedented. Labour supporters who are also anti-Brexit will tell
you that this was because Labour made the election about austerity
(or more accurately the size of the state) rather than about Brexit.
If instead Labour had campaigned against Brexit, the election would
have been a rerun of the referendum (as May wanted it to be) and
because of the geographical concentration of the pro-EU vote Labour
would have lost badly.

Even if you buy
this, however, there remains a question of whether the triangulation
strategy will continue to work, and whether it could have the
unfortunate side-effect of ensuring Brexit will happen when otherwise
it might be stopped. To assess this question, we need to take a
realistic view of how the Brexit process is likely to evolve.

We know pretty well
what the final deal will look like. It will be along the lines of the
deal put on the table by the EU, together with a transition period
during which we stay in the customs union and Single Market (and
continue to pay for that privilege). We know this because the Article
50 process gives the EU the whip hand: the No Deal outcome, which is what happens if time runs out, is
so much worse for the leaving country and there is no time to
negotiate a trade deal. [1] As a result, to use a term loved by
Conservative politicians but which in this case happens to be true,
there is no alternative deal to be done.

The only risk before
the election would be that the government would walk away. The
election had made that much less likely. As there has been virtually
no preparation for that outcome, it would bring chaos. This chaos
would ensure that Theresa May’s successor lost any subsequent
election. While the Brexiteers in safe seats might be prepared to see
that happen, the rest of the party would not. Faced with a split in
the Conservative party, Labour could not side with the government, as
it would flip its triangulation strategy and lose a lot of its core
support. As a result, a No Deal Brexit would fail. [2]

What this means is
that we will leave the EU in 2019, but remain in the Single Market
and customs union until both sides negotiate something else. Can a
final deal of this kind be stopped? Logically you might think that
MPs would realise that, compared to EU membership, all this deal does
is mean the UK gets no say in the rules governing the Single Market
and in addition we have to pay a significant sum of money for that
lack of control! It is pure lose, lose, with the only positive (from
a Leavers point of view) being the possibility of avoiding Freedom of
Movement at some future date.

Unfortunately logic
is something not normally associated with Brexit. In reality I
suspect most Conservative MPs will agree to this (for the moment)
softest of soft Brexits with a sigh of relief, telling themselves
that they have fulfilled the will of the people with as little damage
as possible. The triangulation strategy, which is essentially
designed to prevent Brexit becoming a pro/anti party political issue,
suggests Labour will go along with this. The only way either of these
things might not happen is if public opinion turns against Brexit
over the next year.

Will opinion move by
enough to at least make it possible to get a vote for a second
referendum through parliament? Who knows, but there are some
structural factors against it. The first is the right wing press,
which after all are the people who got us into this mess. The second
concerns the broadcast media. Its operating model is based on a two
party system, and if neither of these parties are making the case
that our current difficulties are a result of Brexit then that case
will not receive the exposure it deserves.

Here we get to why
many of those who oppose Brexit are angry at Labour’s position.
They feel that without a major party constantly reminding the public
of the problems that Brexit is creating their chance of turning
public opinion is much reduced. I suspect Labour’s response, if it
was honest about what it was doing, would be to say that they will
not risk the next election by taking a public anti-Brexit position.
It is the Conservatives who got us into this mess, and they have to
make the first move to get us out. The retort that Labour
are reducing the scope of what they can do in government by allowing
Brexit to happen has less force if we are staying
in the Single Market and customs union.

This is related to
the argument made by John Harris, which is that a vote to reverse
Brexit would do nothing to reverse what caused the Brexit vote in the
first place. If Brexit was stopped, UKIP would be given a new lease
of life, and “the myth of betrayal ... would sit at the heart of
our politics”.
To recast what he is saying in my own words, you
cannot undo social conservatism and the effects of economic
deprivation, plus a decade or more of propaganda from the press, with
a single vote of parliament. It is related to the earlier argument
because Labour might say that they cannot reverse these same forces
by a year of campaigning against Brexit before we leave.

Unfortunately there
seems to be no reason why this state of affairs should change during
the transition period. The government, committed to controlling
immigration, will be determined to get a deal that ends free
movement. Labour, to avoid immigration becoming too much of an
election issue, will continue to triangulate. The best [3] hope I can
see to avoid further Brexit damage is for Labour to defeat the
Conservatives at an election, and quickly realise that they are
better off staying in the Single Market and encouraging free
movement. Which of course gets us back to why they are triangulating
in the first place.

[1] It was designed
in part to discourage countries leaving the EU. As David Allen Green
suggests,
there was a better way to leave the EU.

[2] We have
gradually seen the government inching their way towards the EU
proposals. (Remarks by Boris Johnson, like those of Donald Trump, are
a distraction that it is best to ignore.) They are taking their time
because the UK side has almost no power in the negotiations, and it
is better to gradually concede to minimise any negative reaction
among Brexiteers or the public. (Part of the problem here is that
because the government still maintains a public stance that is pure
fantasy, and the opposition wants to stay deliberately vague, the
media feel unable to be straight on these issues with the public. It
also requires
effort to dispel fantasy with reality.)

Monday, 17 July 2017

In its recent report
on fiscal risks, the OBR talks a lot about all the shocks that could
make the government debt to GDP ratio rise again. It then says the
following:

“None of this
should be taken as a recommendation to refrain from particular
spending increases or tax cuts, or to avoid particular fiscal risks –
that would lie beyond our remit. And there are those who believe
fiscal policy is still too tight, given the pace of economic growth
and the looseness of monetary policy. But ….”

Should I be grateful
for the second sentence, being one of ‘those’ who think that way?

I think the reverse
is true. The OBR has played the tune the government wanted,
but it is the wrong tune, and this now mature and independent
organisation is capable of much better than this. I will first deal
with a particular issue to do with monetary policy, and then talk
more generally about the concept of ‘fiscal risks’.

Our macroeconomic
institutional architecture is based around what I have called
the consensus view about macroeconomic policy. This consensus
involves what economists call an assignment. The stabilisation of
output and inflation is assigned to independent central banks
operating monetary policy. Fiscal policy should be confined to
managing the government’s deficit and debt, and to help it with
that task there should be a combination of fiscal rules and
independent fiscal institutions (aka fiscal councils, like the OBR).In a consensus assignment world, the job of a fiscal council is to stop deficit bias: the tendency clearly observable in some countries before the global financial crisis for deficits to creep up over time. In particular, when all is going well and the deficit appears not to be an issue, it is their job to tell the government to 'fix the roof while the sun shines’.

As I and others have
noted many times, this consensus assignment has an Achilles Heel,
which is that nominal interest rates cannot go below a number close
to zero, the so-called Zero Lower Bound (ZLB). In the absence of some
mechanism to allow interest rates to become significantly negative,
that ZLB problem means that sometimes fiscal policy makers have to
help monetary policy in its stabilisation role. The simple consensus
assignment breaks down.

Although most
academic macroeconomists recognise that, our institutions find it
hard to do so. Monetary policymakers in the UK and Eurozone find it
very difficult to say that they have lost their main instrument, and
that therefore they can no longer reliably do their job. It seems
that our fiscal council, the OBR, has similar problems.

We are currently at the ZLB. The most immediate risk we therefore face is that we are
hit by a negative shock and monetary policy is unable to respond
effectively. Hence the quote from their document above. But as far as
I can see that is it. In their section in the Executive Summary on
the risk due to a recession I would have thought the ZLB problem was
worth at least mentioning, but it does not appear. Indeed I’m not
sure the term ZLB or liquidity trap appear anywhere in the document.

I’m sure the OBR
would in defence say two things: assessments of fiscal risks
generally look at risks to fiscal sustainability not macroeconomic
stabilisation, and their remit precludes them from talking about
alternative fiscal policy paths. This is all true. The Treasury
wanted a report that would enable them to say we must continue with
austerity because of all the risks identified by the OBR. The
Treasury also wrote the OBR’s current remit.

But the OBR is
supposed to be independent. Just because the government tries to
pretend that there is no Achilles Heel to the consensus assignment,
that does not mean it has to go along with that act. In particular,
it will (I hope) have noted that the main opposition - which came
close to defeating the current government - has a fiscal rule that
explicitly says that fiscal policy needs to switch from stabilising
debt to stabilising the economy when interest rates are at their
lower bound (like now). In this context, I think something beyond a
single sentence alluding to the ZLB would have been appropriate.

Tony Yates said
similar things yesterday. He also made another important point: a key
role of government in many areas is to be a risk absorber. It assumes
risks, because it is beneficial to take risks away from individuals
or individual generations and spread them more widely, and often the
state is the only institution that can do this. In addition, its
deficit and debt should be a macroeconomic shock absorber. Given all
that, why exactly should we be concerned if various shocks increase
government debt? That is what is supposed to happen!

To put the term risk
and attach it to some level of debt or deficit, giving us ‘fiscal
risks’, is questionable. It is a bit like saying their is a risk
that your central heating will come on if it gets cold: that is not a risk, but why
it is there. The OBR would no doubt respond that the government has a
mandate in terms of a deficit or debt target, and it has been asked
to look at risks that this may not be met. But that should not stop an independent OBR from asking more fundamental questions.

Implicit in the idea
of ‘fiscal risks’ is either a belief that there is an optimal
level of debt which is below current levels, or a view that there is
some level of debt so high that markets would start worrying about
the government choosing to default. If we are worried about a debt burden on
future generations, does it make sense to put all that burden on a
current, already disadvantaged, younger working generation? Unless
these key issues are addressed, all the risk assessment the report
undertakes is meaningless, or worse still just provides support for
the government’s misguided policy. It is time the OBR stopped being constrained by its remit, and started providing the public with a
useful framework in which to think about ‘fiscal risks’.

Friday, 14 July 2017

An interesting
disagreement
occurred this week between Martin Sandbu and the Economist, which
prompted a subsequent letter
from Philippe Legrain (see also Martin again here).
The key issue is whether the German current account surplus, which
has steadily risen from a small deficit in 2000 to a large surplus of
over 8% of GDP, is a problem or more particularly a drag on global
growth.

To assess whether
the surplus is a problem, it is helpful to discuss a key reason why
it arose. I have talked about this in detail many times before, and a
similar story has been told
by one of the five members of Germany’s Council of Economic
Experts, Peter Bofinger.A short summary is that from the moment the
Eurozone was born Germany allowed wages to increase at a level that
was inconsistent with the EZ inflation target of ‘just below 2%’.
We can see this clearly in the following chart.

Relative unit labour
costs, source OECD Economic Outlook, 2000=100

The blue line shows
German unit labour costs relative to its competitors compared to the
same for the Euro area average. Obviously Germany is part of that
average, so this line reduces the extent of any competitiveness divergence between
Germany and other union partners. By keeping wage inflation low from
2000 to 2009, Germany steadily gained a competitive advantage over
other Eurozone countries.

At the time most
people focused on the excessive inflation in the periphery. But as
the red line shows, this was only half the story, because wage
inflation was too low in Germany compared to everyone else. This
growing competitive advantage was bound to lead to growing current
account surpluses.

However that in
itself is not enough to say there is a problem, for two related
reasons. First, perhaps Germany entered the Eurozone at an
uncompetitive exchange rate, so the chart above just shows a
correction to that. Second, perhaps Germany needs to be this
competitive because the private sector wants to save more than it
invests and therefore to buy foreign assets.

There are good
reasons, mainly to do with an ageing population, why the second point
might be true. (If it was also true in 2000, the first point could
also be true.) It makes sense on demographic grounds for Germany to
run a current account surplus. The key issue is how big a surplus.
Over 8% of GDP is huge, and I have always thought that it was much
too big to simply represent the underlying preferences of German
savers.

I’m glad to see
the IMF agrees. It suggests
that a current account surplus of between 2.5% to 5.5% represents a
medium term equilibrium. That would suggest that the competitiveness
correction that started in 2009 has still got some way to go. Why is
it taking so long? This confuses some into believing that the 8%
surplus must represent some kind of medium term equilibrium, because
surely disequilibrium caused by price and wage rigidities should have
unwound by now. The answer to that can also be found in an argument
that I and others put forward
a few years ago.

For this
competitiveness imbalance to unwind, we need either high wage growth
in Germany, low wage growth in the rest of the Eurozone, or both.
Given how low inflation is on average in the Eurozone, getting below
average wage inflation outside Germany is very difficult. The
reluctance of firms to impose wage cuts, or workers to accept them, is well known. As a result, the unwinding of competitiveness
imbalances in the Eurozone was always going to be slow if the
Eurozone was still recovering from its fiscal and monetary policy induced recession and therefore Eurozone average inflation was low. [1]

In that sense German
current account surpluses on their current scale are a symptom of two
underlying problems: a successful attempt by Germany to undercut
other Eurozone members before the GFC, and current low inflation in
the Eurozone. To the extent that Germany can make up for their past
mistakes by encouraging higher German wages (either directly, or
indirectly through an expansionary fiscal policy) they should. Not
only would that speed adjustment, but it would also discourage a
culture within Germany that says it is generally legitimate to
undercut other Eurozone members through low wage increases. [2]

From this
perspective, does that mean that the current excess surpluses in
Germany are a drag on global growth? Only in a very indirect way. If
higher German wages, or the means used to achieve them, boosted
demand and output in Germany then this would help global growth.
(Remember that ECB interest rates are stuck at their lower bound, so
there will be little monetary offset to any demand boost.) The
important point is that this demand boost is not so that Germany can
help out the world or other union members, but because Germany should
do what it can to correct a problem of its own making.

[1] Resistance to
nominal wage cuts becomes a much more powerful argument for a higher
inflation target in a monetary union where asymmetries mean
equilibrium exchange rates are likely to change over time.

[2] The rule in a
currency union is very simple. Once we have achieved a
competitiveness equilibrium, nominal wages should rise by 2% (the
inflation target) more than underlying national productivity. I
frequently get comments along the lines that setting wages lower than
this improves the competitiveness of the Eurozone as a whole. This is
incorrect, because if all union members moderate their wages in a
similar fashion EZ inflation would fall, prompting a monetary
stimulus to bring inflation back to 2% and wage inflation back to 2%
plus productivity growth.

Wednesday, 12 July 2017

Economics students
are taught from an early age that in the short run aggregate demand
matters, but in the long run output is determined from the supply
side. A better way of putting it is that supply adjusts to demand in
the short run, but demand adjusts to supply in the long run. A key
part of that conceptualisation is that long run supply is independent
of short run movements in demand (booms or recessions). It is a
simple conceptualisation that has been extremely useful in the past.
Just look at the UK data shown in this post:
despite oil crises, monetarism and the ERM recessions, UK output per
capita appeared to come back to an underlying 2.25% trend after WWII.

Except not any more:
we are currently more than 15% below that trend and since Brexit that gap is growing larger every quarter. Across most advanced countries, it
appears that the global financial crisis (GFC) has changed the trend
in underlying growth. You will find plenty of stories and papers that
try to explain this as a downturn in the growth of supply caused by
slower technical progress that both predated the GFC and that is independent of the recession caused by it.

In a previous post
I looked at recent empirical evidence that told a different story:
that the recession that followed the GFC appears to be having a
permanent impact on output. You can tell this story in two ways. The
first is that, on this occasion for some reason, supply had adjusted
to lower demand. The second is that we are still in a situation where
demand is below supply.

The theoretical
reasons why supply might adjust to demand are not difficult to find. (They are often described by economists under the jargon word 'hysteresis'.) Supply (in terms of output per capita) depends on labour force
participation, the amount of productive capital in the economy, and
finally technical progress, which is really just a catch all for how
aggregate labour and capital combine to produce output. A long period
of deficient demand can discourage workers. It can also hold back
investment: a new project may be profitable but if there is no demand
it will not get financed.

However the most
obvious route to link a recession to longer term supply is through
technical progress, which connects to the vast literature under the
umbrella of ‘endogenous growth theory’.This can be done through a simple AK model (as
Antonio Fatas does here),
or using a more elaborate model of technical progress, as Gianluca
Benigno and Luca Fornaro do in their paper
entitled ‘Stagnation traps’. The basic idea is that in a
recession innovation is less profitable, so firms do less of it,
which leads to less growth in productivity and hence supply. Narayana
Kocherlakota has promoted this idea: see here
for example.

The second type of
explanation is attractive, in part because the mechanism that is
meant to get demand towards supply - monetary policy - has been ‘out
of action’ for so long because of the Zero Lower Bound (ZLB). (The
ZLB also plays an important role in the Benigno & Fornaro model.)
However for some this type of explanation currently seems ruled out by the
fact that unemployment is close to pre-crisis levels in the UK and US
at least.

There are three
quite different problems I have with the view that we no longer have
a problem of deficient demand because unemployment is low. The first,
and most obvious, is that the natural rate of unemployment might be,
for various reasons, considerably lower than it was before the GFC.
The second is that workers may have priced themselves into jobs. In
particular, low real wages may have encouraged firms to use more
labour intensive techniques. If that has happened, it does not mean
that the demand deficiency problem has gone away, but just that it is
more hidden. (For anyone who has a conceptual problem with that, just
think about the simplest New Keynesian model, which assumes a
perfectly clearing labour market but still has demand deficiency.)

The third involves
the nature of any productivity slowdown caused by lack of innovation.
A key question, which the papers noted above do not directly address,
is whether we are talking about frontier research, or more the
implementation of innovation (for example, copying what frontier
firms are doing). There is some empirical evidence
to suggest that the productivity slowdown may reflect the absence of
the latter. This is very important, because it implies the slowdown
is reversible. I have argued that central banks should pay much more
attention to what I call the innovation gap (the gap between best
practice techniques, and those that firms actually employ) and its
link to investment and aggregate demand.

All this shows that
there is no absence of ideas about how a great recession and a slow
recovery could have lasting effects. If there is a problem, it is
more that the simple conceptualisation that I talked about at the
beginning of this post has too great a grip on the way many people think. If any
of the mechanisms I have talked about are important, then it means
that the folly of austerity has had an impact that could last for at
least a decade rather than just a few years.

Monday, 10 July 2017

Ben Chu has a good
article
disposing of some of the nonsense ideas associated with austerity
(which refuse to die, because they are useful to politicians, and
much of the media is generally clueless). Perhaps the most silly,
which I encounter a lot, is that the UK has not really endured
austerity because debt has been increasing, or some other irrelevant
measure has been rising.

If trying to reduce
the deficit - what economists call fiscal consolidation - had no
adverse effects on the economy as a whole it would not be called
austerity. Austerity is all about the negative aggregate impact on
output that a fiscal consolidation can have. As a result, the
appropriate measure of austerity is a measure of that impact. So it
is not the level of government spending or taxes that matter, but how
they change.

An obvious measure
to use is the change in the deficit itself, generally adjusted for
changes that happen automatically because output is changing. I have
used that measure many times, because it is produced by the OBR, IMF
and OECD among others. But it is not ideal, because the impact of
changes in taxes on demand and therefore output is generally smaller
than the impact of a change in government spending, because some of
any tax increase comes from reduced saving. (This is also true, but
perhaps to a lesser extent, of government transfers.)

There is no simple
way of dealing with this measurement problem, because the amount of
any tax increase people will find from their savings will depend in part on how long they
expect taxes to be higher. As a result, some people prefer to focus just
on government spending to measure fiscal impact (although the data
you will easily find is government consumption, and as fiscal
consolidation normally involves cuts to government investment it is
important to add that on). However it is also possible to apply some
simple average propensities to consume from tax cuts and transfers to
get a fiscal impact measure.

This is what the
Hutchins Center fiscal impact measure
does for the US.

These are not
multipliers (so are different from what the OBR does for the UK, for
example [1]), but just the direct impact of government spending and
taxes on aggregate demand and hence GDP. The average total impact is
something like 0.4%, so this would be fiscal policy that was in this
sense neutral.

Compare the mild
2001 recession with the much larger 2008/9 recession. In both cases
during the recession fiscal policy was strongly counter-cyclical,
helping to reduce the recession’s impact. After the 2001 recession
ended, fiscal policy continued to support the recovery for around two
years: these were the Bush tax cuts. The recovery in GDP was
reasonably strong: growth from 2003 to 2005 of 2.8%, 3.8% and 3.3%.

In 2010, we had a
much deeper and longer recession, but the fiscal support was only
marginally greater than 2001, despite interest rates being stuck at
their lower bound. On this occasion fiscal support was strongly
opposed by the Republicans. It continued for another year and a
quarter, and then became strongly contractionary from 2011 to 2015.
GDP growth was slower than in the previous recovery, despite
the deeper recession: from 2010 to 2014 2.5%, 1.6%, 2.2%, 1.7%,
2.4%. This is not surprising, as fiscal policy was reducing GDP by
around 1% during 2011,2012 and 2013, rather than adding the normal 0.4%.

The speed and extent
to which austerity was applied after the Great Recession was very
unusual: the textbook says secure the recovery first, allow interest
rates to rise, and then worry about government debt. There was no
economic justification for switching to austerity so quickly after
2010: the motivation (as in the UK) was entirely political. It
produced the slowest US recovery in output since WWII. (This
is a very useful resource in comparing US upswings.) As I showed
here
using simple calculations, if total government spending from 2011 had
remained neutral instead of becoming sharply contractionary, US
output could easily have got close to capacity (as measured by the
CBO) by 2013.

To subtract 1.5%
from GDP would not matter if something (consumption, investment or
net exports) filled its place. But that will only happen by chance or
because of a monetary policy stimulus, and monetary policy was stuck
in a liquidity trap. This is the real crime of austerity. Decreasing
demand and output just when the economy is beginning its recovery
from the deepest recession since WWII is as foolish as it sounds, but
to do this at just the time that monetary policy was unable to
effectively fight back is macroeconomic madness. As I will argue in
later posts, it looks increasingly likely that this has made us all
permanently poorer.

[1] If somebody
publishes similar estimates for the UK, please let me know.
Personally I think it makes more sense to publish data like this than
use a multiplier based analysis, simply because these measures are
more direct, and involve fewer ‘whole economy’ assumptions.
Crucially, there are no implicit assumptions about monetary policy
being made. It would be interesting to know why the OBR decided not
to take this approach.